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Business Analysis & Features

The Autonomy saga: Clouds over Britain's tech stars

Fraud claims at success story Autonomy raise questions over the sector

The scandal over alleged financial irregularities at Autonomy has shaken confidence across the British technology industry. The Cambridge-based company was a rare home-grown tech success, the biggest computing firm on the FTSE 100 until it was bought last year by United States giant Hewlett-Packard for $11.1bn (£8.9bn).

Autonomy was the company that was held up as a shining star by ministers of all political stripes, who hailed founder Mike Lynch as a leader and inspiration for other tech entrepreneurs. No wonder, when Britain is sorely lacking in tech success stories that can compare even remotely with the likes of Apple, Google, Amazon, Microsoft and IBM.

Alas this week's jaw-dropping allegations of fraud, which are vigorously denied by Autonomy and Dr Lynch, and an $8.8bn writedown by HP have changed everything.

In essence, HP is claiming it does not believe the revenues that Autonomy declared in its accounts. The British firm stands accused of selling some computer hardware at a loss and treating part of the cost of those sales as a marketing expense.

More seriously, there are allegations of "channel stuffing" when a company claims it had sold software before it had actually been bought by an end-user, effectively booking future revenues in advance.

It will take months and probably years for regulators and lawyers to get to the bottom of these claims, which were raised after Dr Lynch left this year.

But it raises wider questions for the whole industry, especially as it comes at a sensitive time just as British-based firms and venture capitalists are calling on City regulators in a bid to relax rules on financial disclosure for tech companies floating in London. The Autonomy saga hardly boosts the case of the tech lobby, which has been loudly complaining that the City must cut red tape or risk losing out to New York's Nasdaq and Hong Kong as a place to raise money.

Questions of transparency are not confined to the UK. Industry insiders have been talking for years about the issue of how software firms book revenue in their accounts, or "revenue recognition" as analysts like to describe it.

Once upon a time, computing giants got fat selling big software packages to clients and taking the cash upfront. That made the accounting relatively transparent.

However, in recent years, with the rise of cloud-based computing, there has been a trend towards software as a service and subscriptions. Clients have been shelling out far less revenue on an annual basis, as contracts stretch out over several years, and payments tend to be in arrears, rather than upfront.

This trend has accelerated after the banking crisis of 2007-8 as big corporate clients have been anxious to pay out as little cash as possible in one go. As a result, say City analysts, it has become harder to monitor exactly how successful some tech companies are, as it all depends when they recognise revenue in their accounts.

It is easy to see why this could be problematic. If revenues are paid in arrears, it makes the growth rate lower. Conversely, if a company can book those revenues now, it makes the growth rate look rather better. This matters hugely when company valuations, especially in the tech sector, are based on future revenue and earnings forecasts.

One well-placed source says problems about revenue recognition are "not endemic" but it is something that City analysts are vigilant about.

In the case of Autonomy, concerns were first felt years ago. Daud Khan, then at JPMorgan Cazenove, and Paul Morland, then at broker Astaire but now at Peel Hunt, were among the analysts say they had serious questions about Autonomy.

Whatever the outcome turns out to be for Autonomy, the shame is that this saga is casting a shadow over a company with a track record for innovation.

Autonomy made its name by making creating software that could make sense of unstructured information — emails, texts, voice calls and so on — using Bayes's Theorem, based on the ideas of Thomas Bayes, an 18th-century cleric. He reckoned it was possible to look at the relationship between pieces of information and tell how they would be affected when new information is introduced, something Dr Lynch applied to the world of cloud computing. Autonomy came up with other pioneering ideas too, including Aurasma, augmented reality technology that is being used on smartphone and iPad screens.

Sadly, Autonomy's corporate reputation is under threat. "What makes me sad about this whole thing is the Americans will be whooping it up at our expense," says one observer, speaking privately.

"The news broke on the same day as that guy at UBS, Kweku Adoboli, is jailed. It makes us [the City] look like the Wild West out here. It is otherwise a great sector in the UK."